Part IV of Thinking, Fast and Slow


This section focuses on two ideas.  Behavior depends on starting state as well as change.  Prospect theory summarizes this.  You can not use mathematical expected value to predict how people will value wagers and risks.  Basically people will take risks to avoid losses.  They will also pay a cost to get a sure gain.  The rest of the chapters in Part IV give some interesting outcomes of this.

The Endowment Affect:  Ownership itself has value.  If someone is holding something like a ticket to use they will only sell it for a price higher than they would pay to buy it if they didn’t own it.  If someone is holding something only to sell they treat it more like money.  There is no endowment affect.

Negotiating: Negotiating is hard because loss aversion is stronger than the will to gain on both sides.

Possibility effect:  The chance to win something has value.  The change in probability to win something from 0%-5% has more value than any other 5% increase.

Certainty effect:  A certain opportunity to win a prize has value.  This is why court settlements can be worth less than the expected win.  The combination of the possibility effect and certainty affect can make it hard to settle.  The defendant will gamble on owing nothing.  The plaintiff will want a settlement.

Rare Events:  Rare events are often over-weighted, especially if one can visualize the event happening.  A person asked about teams’ chances to win a tournament one team at a time will usually have probabilities  that add to more than 100%.  Rare events that have never happened can be under-weighted.  They aren’t easily visualized.  This explains lax disaster preparation.  Personally I’m a little skeptical of this section because it assumes people understand percents and understand using percents as probabilities.

Risk Policies:  Look at all your risks at once or have a policy in place on how to decide in order to make good decisions.  If you allow the certainty effect and possibility effect to influence your decisions you will consistently lose.  A company may see this problem in its management structure.  Vice presidents may not want to take a gamble that will either double their business or eliminate it from their part of the company.  But, if all parts of the company took such risks their is a very high probability the company comes out ahead.

Sunk Cost Fallacy:  They give a good example that shows people like to see wins and not losses.  11 months of the year people sell winning stocks.  They should sell losers because of US tax policy.  In December people actually do sell losing stocks.  Usually thought people do not want to admit things did not go well.  People who pay for a ticket will usually expend more effort (drive through a blizzard) to go to a sporting event than those who get the ticket for free.)

I still have a couple chapters to read in this part of the book, but it has been awhile since I posted.


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